Fail safe

  • Author : Grant Jones
  • Date : April 2012
ABOUT THE AUTHOR: Grant Jones is a Solicitor, a Chartered Accountant, a Licensed Insolvency Practitioner and a Partner at Cooper Parry LLP, practising in London and Guernsey

It’s the age of austerity and a UK-based charitably inclined volunteer trustee is exposed through an ‘unincorporated trust’ in financial difficulties. As both trustee and trust lack incorporated protection, personal liability, i.e. trustee bankruptcy, follows. The classic case is that of a long-standing educational trust running a school. There is a scandal: a tipping point for recession-hit, fee-sensitive parents. How can the trusted advisor assist?

This article argues that personal bankruptcy may be avoided by using, or perhaps abusing, a little-known corporate vehicle, the ‘unregistered company’, under part 5 of the UK Insolvency Act 1986 (the Act), or the inherent power of the court. In any event, the UK needs a separate new insolvent trust regime.

But what should you be telling your client now? In a trustee bankruptcy, there will be a sense of ‘I told you so’: you should have ‘contracted with limited liability’, ‘incorporated’, or ‘run your business better’. These suggestions are true. The trusted advisor should health-check their unincorporated trust clients.

Limited liability

Contracting with limited liability is sensible. Every contract states that the ‘counterparty can only have recourse to the trust assets, not recourse to the trustee’s other assets’. There are three issues here. First, it’s scary. People happily form a contract with limited liability companies and think nothing of it. However, if a trustee does this, it looks very unusual. Avoid regular long post-signature legal disclaimers, via a standard contract on which all further purchases are based. The problem here is the ‘battle of the forms’: supplier and purchaser both sending off their standard terms, and both considering that their standard terms reign supreme.

Second, many creditors are involuntary creditors. You do not make a contract with them, e.g. taxation. So forming a contract with limited liability at best ameliorates. Third, it may not actually help because of UK bankruptcy law intricacies. The UK does not have a separate bankrupt trustee insolvency regime. It should. Trustee insolvencies are an animal apart. The bankrupt trustee’s estate and liabilities are divided between non-trust and trust elements. Non-trust creditors do not have recourse to the trust assets. If the trustee made a contract with limited liability, the trust creditors do not have recourse to the non-trust assets.

‘Trustees should have an intervening entity shielding them from personal liability’

So it is correct to say the trustee’s personal assets (such as their home) could be protected if they formed a contract with limited recourse. But because the trustee was regarded as ‘trading’ in their own name (why they are personally liable), they may still go bankrupt if the trust is insolvent. This perverse result happens because the trust does not have legal status separate from that of the trustee. One person, the trustee, ‘trades’ in two names: the trust’s and theirs. The trustee could therefore become bankrupt because there is a deficiency in the trust, but they could protect their home because the trust creditors had no recourse to their personal assets. The problem is, however, that they have become ‘a bankrupt’ and much will follow from that simple statement.

Tax and trust donation issues aside, the trustees should have an intervening limited liability incorporated entity shielding them from personal liability, i.e. incorporation. As to running your ‘business’ better, that is for the management consultants.

But what happens after the horse has bolted? No bankruptcy shielding incorporation took place. Your client trustee faces bankruptcy. The mainstream thought can be encapsulated in this judicial comment, when dismissing a ‘creditor’s petition to liquidate the company’, in Gilbert Deya Ministries v Kashmir Broadcasting Corp [2010] (Deya): ‘It is plain that as the charity is not constituted as a limited liability company under part 4 of the Act, it cannot be wound up pursuant to s123, which deals with companies registered under the Companies Act. The creditor should have sought to hold the trustees personally liable for the debt and could bankrupt the trustees if necessary.’

Advisors do not like trustee bankruptcy. The creditor, Gilbert Deya Ministries, could have argued it was a part-5 unregistered company (but perversely it argued the opposite) or it could have sought the inherent jurisdiction of the court to wind up the company. Both options avoid direct personal liability. These suggested routes have difficulties; they are not panaceas. But when the other choice is client personal bankruptcy, they should be explored.

Unregistered companies

So what is an unregistered company? And what about the inherent powers of the court? Section 220(1) of the Act states: ‘An unregistered company includes any association and any company, with the exception of a company registered under the [UK] Companies Act…’ Unregistered companies tend to be non-UK companies, i.e. companies not registered under the UK Companies Act. But they can also be ‘associations’. Traditionally, it was thought to refer only to associations formed for profit or gain.

Plainly, charities, per se, can be subject to insolvency. But does the charitable function undertaken by the trustee have an element of gain or profit? Deya considered a further question as obiter: ‘Can a trust also be an unregistered company?’ Deya said ‘unlikely’, but the Judge acknowledged that he did not have the benefit of full argument and, importantly, the petition was contested.

The court has the power under its general equitable jurisdiction to order the winding up of an unincorporated association, independently of the Act, and to give liquidator-like powers to those administering the winding up. For instance, when a trade union could not be wound up as an unregistered company, the court stepped in and the union was dissolved under the inherent power of the court.

Trade or profit

It is submitted that many charitable functions, including education trusts receiving school fees, ‘trade’. Trading charities have grown as part of privatisation. Section 479 of the Corporation Tax Act 2010 defines a charitable trade: ‘(a) the trade is exercised in the course of carrying out the primary purpose of the charitable company, or (b) the working connection with the trade is mainly carried out by beneficiaries of the charitable company.’ Thousands of not-for-profit incorporated companies exist and perhaps commentators have incorrectly focused on the need for profit, not on the need for trade, when analysing whether an entity falls within part 5 of the Act. As to whether a trust can also be an unregistered company, maybe Deya, given that the Judge did not have the benefit of full argument, does not help either way. The important pragmatic issue is ‘whether the petition is contested’.

OK, the argument is it’s an unregistered company – what then? Two possible insolvency processes exist: administration and compulsory liquidation. Administration is designed to preserve the business and liquidation to dissolve the business. Unfortunately, schB1 para 111(1A) of the Act, implementing the EU insolvency regime, now limits administration orders to companies incorporated, or having their main centre of interest, in the UK or EEA. Unregistered companies are not included.

As to liquidation, s221(1) of the Act is clear: ‘Any unregistered company may be wound up under this Act, and all the provisions of this Act about winding up apply to an unregistered company with the exceptions and additions mentioned in the following subsections.’ Interestingly, many of the alterations refer to ‘business’, which is perhaps a more appropriate description of a company than a reference to trade or profit.

Pragmatic considerations

On the assumption that trustees prefer unregistered company directorship to personal bankruptcy, a liquidation petition should be uncontested. Consequently, much of the above discussion is academic. Unregistered status comes in under the radar. Wrong perhaps, but effective. If the liquidation petition, even though desired by the recipients, fails, there is always the inherent jurisdiction of the courts as a fallback. Perhaps advisors need to think laterally when their trustee clients face personal catastrophic insolvency. Pending the UK implementing, as other jurisdictions have, a specific, clear trust insolvency regime, ill-fitting solutions will be considered. England created the trust; it should consider its failure too.


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